Budget boom or bust?

Chancellor Rachel Reeves was always clear on the goal of the first Labour Budget in 14 years, to fix the foundations of the economy and enable GDP to grow by 2.5% per annum in the medium to long term.

To do this, Reeves announced £70 billion per annum increases in government spending to fund investment and improve public services. The tax increases of £42 billion by 2029/30 will not fund this spending jump, so there will be a £28 billion increase in borrowing in each year of the current parliament.

Reeves also changed former Chancellor Jeremy Hunt's fiscal rules. The new fiscal mandate will be that the government will only borrow to invest, a rule very similar to former Chancellor Gordon Brown’s ‘Golden Rule’ in 1997. In addition, the new Chancellor will use a wider measure of the nation’s liabilities to assess trends in debt, which will facilitate increases in future borrowing to fund investment.

Most of the burden of the announced tax increases will fall on companies, especially via the increase in employers' National Insurance Contributions. High-net-worth individuals will be affected as well. Residential stamp duty on second homes will rise by two percentage points to 5%; pension pots will no longer be exempt from Inheritance Tax (IHT); and application of VAT on private school fees will proceed in January as planned.

However, the measures are less widespread than trailed. The government is retaining 50% of IHT relief on Alternative Investment Market (AIM) stocks, and increases to Capital Gains Tax were not as steep as many had expected, especially for higher-rate taxpayers. We think the decision on AIM is positive as smaller, enterprising, mid-market companies are essential to fuelling UK economic growth.

In the first instance, markets breathed a collective sigh of relief to the Budget. However, sentiment has now turned. By 2pm on 30 October, there was an almost 20-basis-point (bp) rise in 10-year gilt yields, and a further 10 bp followed on 31 October. At the time of writing, these stood at 4.5%. Markets are being driven by nervousness over the scale of the uplift to the borrowing profile and may also be wondering whether there is more to come over the next couple of years. Sterling is also feeling jittery and is now trading a touch below $1.29, having rallied to $1.3050 in the immediate aftermath of the Chancellor's statement.

On the overall fiscal strategy, our view is that it resembles a gambit in chess, where a player sacrifices a piece to gain a longer-term strategic advantage. Increasing investment spend should enhance the capital stock and, in principle, provide the economy with the required tailwind over the medium-to-long term. And an increase in investment from private sector businesses would reinforce this.

But the markets’ nerves are understandable, as this Budget is a calculated risk, which could backfire and leave the UK's fiscal situation in a much weaker position.

This article is for general information purposes only and should not be used or relied upon as professional advice. It is advisable to contact a professional advisor if you need financial advice.